Book Five: General Relations of Demand, Supply and Value

Chapter 9, Marginal Costs in Relation to Values.
General Principles, Continued

1. The incidents of the tenure of land are so complex: and so many practical issues connected with them have raised controversies on side issues of the problem of value, that it will be well to supplement our previous illustration from land. We may take another from an imaginary commodity so chosen that sharp outlines can be assigned to each stage of the problem, without inviting the objection that such sharp outlines are not found in the actual relations between landlord and tenant.

But before entering on this, we may prepare the way for using, as we go, illustrations drawn from the incidence of taxation to throw side-lights on the problem of value. For indeed a great part of economic science is occupied with the diffusion throughout the community of economic changes which primarily affect some particular branch of production or consumption; and there is scarcely any economic principle which cannot be aptly illustrated by a discussion of the shifting of the effects of some tax "forwards," i.e. towards the ultimate consumer, and away from the producer of raw material and implements of production; or else in the opposite direction, "backwards." But especially is this true of the class of problems now under discussion. (1)

It is a general principle that if a tax impinges on anything used by one set of persons in the production of goods or services to be disposed of to other persons, the tax tends to check production. This tends to shift a large part of the burden of the tax forwards on to consumers, and a small part backwards on to those who supply the requirements of this set of producers. Similarly, a tax on the consumption of anything is shifted in a greater or less degree backwards on to its producer.

For instance, an unexpected and heavy tax upon printing would strike hard upon those engaged in the trade, for if they attempted to raise prices much, demand would fall off quickly: but the blow would bear unevenly on various classes engaged in the trade. Since printing machines and compositors cannot easily find employment out of the trade, the prices of printing machines and wages of compositors would be kept low for some time. On the other hand, the buildings and steam engines, the porters, engineers, and clerks would not wait for their numbers to be adjusted by the slow process of natural decay to the diminished demand; some of them would be quickly at work in other trades, and very little of the burden would stay long on those of them who remained in the trade. A considerable part of the burden, again, would fall on subsidiary industries, such as those engaged in making paper and type; because the market for their products would be curtailed. Authors and publishers would also suffer a little; because they would be forced either to raise the price of books, with a consequent diminution of sales, or to see a greater proportion of their gross receipts swallowed up by costs. Finally, the total turnover of the booksellers would diminish, and they would suffer a little.

So far it has been assumed that the tax spreads its net very wide, and covers every place to which the printing industry in question could be easily transferred. But, if the tax were only local, the compositors would migrate beyond its reach; and the owners of printing houses might bear a larger and not a smaller proportionate share of the burden than those whose resources were more specialized but more mobile. If the local tax were uncompensated by any effect which tended to attract population, part of the burden would be thrown on local bakers, grocers, etc., whose sales would be diminished.

Next suppose the tax to be levied on printing presses instead of on printed matter. In that case, if the printers had no semi-obsolete presses which they were inclined to destroy or to leave idle, the tax would not strike marginal production: it would not immediately affect the output of printing, nor therefore its price. It would merely intercept some of the earnings of the presses on the way to the owners, and lower the quasi-rents of the presses. But it would not affect the rate of net profits which was needed to induce people to invest fluid capital in presses: and therefore, as the old presses wore out, the tax would add to marginal expenses, that is to expenses which the producer was free to incur or not as he liked, and which he was in doubt whether to incur. Therefore the supply of printing would be curtailed; its price would rise: and new presses would be introduced only up to the margin at which they would be able, in the judgment of printers generally, to pay the tax and yet yield normal profits on the outlay. When this stage had been reached the distribution of the burden of a tax upon presses would henceforth be nearly the same as that of a tax upon printing: excepting only that there would be more inducement to get a great deal of work out of each press. For instance more of the presses might be made to work double shifts; in spite of the fact that night work involves special expenses.

We now pass to apply these principles of shifting of taxes to our main illustration.

2. Let us suppose that a meteoric shower of a few thousand large stones harder than diamonds fell all in one place; so that they were all picked up at once, and no amount of search could find any more. These stones, able to cut every material, would revolutionize many branches of industry; and the owners of them would have a differential advantage in production, that would afford a large producer's surplus. This surplus would be governed wholly by the urgency and volume of the demand for their services on the one hand and the number of the stones on the other hand: it could not be affected by the cost of obtaining a further supply, because none could be had at any price. A cost of production might indeed influence their value indirectly: but it would be the cost of tools made of hard steel and other materials of which the supply can be increased to keep pace with demand. So long as any of the stones were habitually used by intelligent producers for work which could be done equally well by such tools, the value of a stone could not much exceed the cost of producing tools (allowance being made for wear and tear) equally efficient with it in these inferior uses.

The stones, being so hard as not to be affected by wear, would probably be kept in operation during all the working hours of the day. And if their services were very valuable, it might be worth while to keep people working overtime, or even in double or triple shifts, in order to extract the utmost service from them. But the more intensively they were applied, the less net return would be reaped from each additional service forced from them; thus illustrating the law that the intensive working not only of land, but of every other appliance of production is likely to yield a diminishing return if pressed far enough.

The total supply of stones is fixed. But of course any particular manufacturer might obtain almost as many as he liked to pay for: and in the long run he would expect his outlay on them to be returned with interest (or profits, if the remuneration for his own work were not reckoned separately), just in the same way as if he were buying machinery, the total stock of which could be increased indefinitely, so that its price conformed pretty closely to its cost of production.

But when he had once bought the stones, changes in the processes of production or of demand for the things made by their aid, might cause the income yielded by them to become twice as great or only half as great as he had expected. In the latter case it would resemble the income derived from a machine, which had not the latest improvements and could earn only half as much as a new machine of equal cost. The values of the stone and of the machine alike would be reached by capitalizing the income which they were capable of earning, and that income would be governed by the net value of the services rendered by them. The income earning power and therefore the value of each would be independent of its own costs of production, but would be governed by the general demand for its products in relation to the general supply of those products. But in the case of the machine that supply would be controlled by the cost of supply of new machines equally efficient with it; and in the case of the stone there would be no such limit, so long as all the stones in existence were employed on work that could not be done by anything else.

This argument may be put in another way. Since any one, who bought stones, would take them from other producers, his purchase would not materially affect the general relations of demand for the services of the stones to the supply of those services. It would not therefore affect the price of the stones; which would still be the capitalized value of the services which they rendered in those uses, in which the need for them was the least urgent: and to say that the purchaser expected normal interest on the price which represented the capitalized value of the services, would be a circular statement that the value of the services rendered by stones is governed by the value of those very services. (2)

Next let us suppose that the stones were not all found at once but were scattered over the surface of the earth on public ground, and that a laborious search might expect to be rewarded by finding one here and there. Then people would hunt for the stones only up to that point, or margin, at which the probable gain of so doing would in the long run just reward the outlay of labour and capital involved; and in the long run, the normal value of the stones would be such as to maintain equilibrium between demand and supply, the number of the stones gathered annually being in the long run just that for which the normal demand price was equal to the normal supply price.

Finally, let us bring the case of the stones into accord with that of the lighter machinery and other plant ordinarily used in manufacture, by supposing that the stones were brittle, and were soon destroyed; and that an inexhaustible store existed from which additional supplies could be obtained quickly and certainly at a nearly uniform cost. In this case the value of the stones would always correspond closely to that cost: variations in demand would have but little influence on their price, because even a slight change in price would quickly effect a great change in the stock of them in the market. In this case the income derived from a stone (allowance being made for wear-and-tear) would always adhere closely to interest on its cost of production.

3. This series of hypotheses stretches continuously from the one extreme in which the income derived from the stones is a rent in the strictest sense of the term, to the other extreme in which it is to be classed rather with interest on free or floating capital. In the first extreme case the stones cannot be worn out or destroyed, and no more can be found. They of course tend to be distributed among the various uses to which they are applicable in such a way that there is no use to which an increased supply of them could be applied, without taking them away from some other use in which they were rendering net services at least as valuable. These margins of application of the several uses are thus governed by the relation in which the fixed stock of stones stands to the aggregate of demands for them in different uses. And the margins being thus governed, the prices that will be paid for their use are indicated by the value of the services which they render at any one of those margins.

A uniform tax on them, collected from the user, will lower their net service in each use by the same amount: it will not affect their distribution between several uses; and it will fall wholly on the owner, after perhaps some little delay caused by a frictional resistance to readjustments.

At the opposite extreme of our chain of hypotheses, the stones perish so quickly, and are so quickly reproduced at about a uniform cost, that variations in the urgency and volume of the uses to which the stones can be put will be followed so promptly by changes in the stock of them available, that those services can never yield much more or much less than normal interest on the money cost of obtaining additional stones. In this case a business man, when making his estimates for the cost of any undertaking in which stones will be used, may enter interest (or if he is counting his own work in, profits), for the time during which those stones will be used (together with wear-and-tear), as part of the prime, special, or direct expenses of his undertaking. A tax on the stones under these conditions would fall entirely on any one who even a little while after the tax had come into force, gave out a contract for anything in making which the stones would be used.

Taking an intermediate hypothesis as to the length of life of the stones and the rapidity with which new supplies could be obtained; we find that the charges which the borrower of stones must expect to pay, and the revenue which the owner of the stones could reckon on deriving from them at any time, might temporarily diverge some way from interest (or profits) on their cost. For changes in the urgency and volume of the uses to which they could be applied, might have caused the value of the services rendered by them in their marginal uses to rise or fall a great deal, even though there had been no considerable change in the difficulty of obtaining them. And if this rise or fall, arising from variations in demand, and not from variations in the cost of the stones, is likely to be great during the period of any particular enterprise, or any particular problem of value that is under discussion; then for that discussion the income yielded by the stones is to be regarded as more nearly akin to a rent than to interest on the cost of producing the stones. A tax upon the stones in such a case would tend to diminish the rental which people would pay for their use, and therefore to diminish the inducements towards investing capital and effort in obtaining additional supplies. It would therefore check the supply, and compel those who needed the stones to pay gradually increasing rentals for their use, up to the point at which the rentals fully covered the costs of producing the stones. But the time needed for this readjustment might be long: and in the interval a great part of the tax would fall upon the owners of the stones.

If the life of the stones was long relatively to that process of production in which the stones were used which was under discussion, the stock of stones might be in excess of that needed to do all the work for which they were specially fitted. Some of them might be lying almost idle, and the owner of these stones might make up his estimate of the marginal price for which he was just willing to work without entering in that estimate interest on the value of the stones. That is to say, some costs which would have been classed as prime costs in relation to contracts, or other affairs, which lasted over a long period, would be classed as supplementary costs in relation to a particular affair which would last but a short time, and which came under consideration when business was slack.

It is of course just as essential in the long run that the price obtained should cover general or supplementary costs as that it should cover prime costs. An industry will be driven out of existence in the long run as certainly by failing to return even a moderate interest on capital invested in steam engines, as by failing to replace the price of the coal or the raw material used up from day to day: just as a man's work will be stopped as certainly by depriving him of food as by putting him in chains. But the man can go on working fairly well for a day without food; while if he is put in chains the check to his work comes at once. So an industry may, and often does, keep tolerably active during a whole year or even more, in which very little is earned beyond prime costs, and the fixed plant has "to work for nothing." But when the price falls so low that it does not pay for the out of pocket expenses during the yea r for wages and raw material, for coal and for lighting, etc., then the production is likely to come to a sharp stop.

This is the fundamental difference between those incomes yielded by agents of production which are to be regarded as rents or quasi-rents and those which (after allowing for the replacement of wear-and-tear and other destruction) may be regarded as interest (or profits) on current investments. The difference is fundamental, but it is only one of degree. Biology tends to show that the animal and vegetable kingdoms have a common origin. But yet there are fundamental differences between mammals and trees; while in a narrower sense the differences between an oak tree and an apple tree are fundamental; and so are in a still narrower sense those between an apple tree and a rose bush, though they are both classed as rosaceae. Thus our central doctrine is that interest on free capital and quasi-rent on an old investment of capital shade into one another gradually; even the rent of land being not a thing by itself, but the leading species of a large genus. (3)

4. Again, pure elements are seldom isolated from all others by nature either in the physical or moral world. Pure rent in the strict sense of the term is scarcely ever met with: nearly all income from land contains more or less important elements which are derived from efforts invested in building houses and sheds, in draining the land and so on. But economists have learnt to recognize diversity of nature in those composite things to which the names of rent, profits, wages etc. are given in popular language; they have learnt that there is an element of true rent in the composite product that is commonly called wages, an element of true earnings in what is commonly called rent and so on. They have learnt in short to follow the example of the chemist who seeks for the true properties of each element; and who is thus prepared to deal with the common oxygen or soda of commerce, though containing admixtures of other elements. (4)

They recognize that nearly all land in actual use contains an element of capital; that separate reasonings are required for those parts of its value which are, and those which are not, due to efforts of man invested in the land for the purposes of production; and that the results of these reasonings must be combined in dealing with any particular case of that income which commonly goes by the name "rent," but not all of which is rent in the narrower sense of the term. The manner in which the reasonings are to be combined depends on the nature of the problem. Sometimes the mere mechanical "composition of forces" suffices; more often allowance must be made for a quasi-chemical interaction of the various forces; while in nearly all problems of large scope and importance, regard must be had to biological conceptions of growth.

5. Finally a little may be said on a distinction that is sometimes made between "scarcity rents" and "differential rents." In a sense all rents are scarcity rents, and all rents are differential rents. But in some cases it is convenient to estimate the rent of a particular agent by comparing its yield to that of an inferior (perhaps a marginal) agent, when similarly worked with appropriate appliances. And in other cases it is best to go straight to the fundamental relations of demand to the scarcity or abundance of the means for the production of those commodities for making which the agent is serviceable.

Suppose for instance that all the meteoric stones in existence were equally hard and imperishable; and that they were in the hands of a single authority: further that this authority decided, not to make use of its monopolistic power to restrict production so as to raise the price of its services artificially, but to work each of the stones to the full extent it could be profitably worked (that is up to the margin of pressure so intensive that the resulting product could barely be marketed at a price which covered, with profits, its expenses without allowing anything for the use of the stone). Then the price of the services rendered by the stones would have been governed by the natural scarcity of the aggregate output of their services in relation to the demand for those services; and the aggregate surplus or rent would most easily be reckoned as the excess of this scarcity price over the aggregate expenses of working the stones. It would therefore generally be regarded as a scarcity rent. But on the other hand it could have been reckoned as the differential excess of the aggregate value of the net services of the stones over that which would have been reached if all their uses had been as unproductive as their marginal uses. And exactly the same would be true if the stones were in the hands of different producers, impelled by competition with one another to work each stone up to the margin at which its further use ceased to be profitable.

This last instance has been so chosen as to bring out the fact that the "differential" as well as the "scarcity" routes for estimating rent are independent of the existence of inferior agents of production: for the differential comparison in favour of the more advantageous uses of the stones can be made by reference to the marginal uses of good stones, as clearly as by reference to the use of inferior stones which are on the margin of not being worth using at all.

In this connection it may be noted that the opinion that the existence of inferior land, or other agents of production, tends to raise the rents of the better agents is not merely untrue. It is the reverse of the truth. For, if the bad land were to be flooded and rendered incapable of producing anything at all, the cultivation of other land would need to be more intensive; and therefore the price of the product would be higher, and rents generally would be higher, than if that land had been a poor contributor to the total stock of produce. (5)

NOTES

1. The substance of this section is reproduced from answers to questions proposed by the Royal Commission on Local Taxation. See [C. 9528], 1899, pp. 112-26.

2. Such circular reasonings are sometimes nearly harmless: but they always tend to overlay and hide the real issues. And they are sometimes applied to illegitimate uses by company promoters; and by advocates of special interests, who desire to influence the course of legislation in their own favour. For instance a semi monopolistic business aggregation or trust is often "over-capitalized." To effect this a time is chosen, at which the branch of production with which it is concerned is abnormally prosperous: when perhaps some solid firms are earning fifty per cent. net on their capital in a single year, and thus making up for lean years past and to come in which their receipts will do little more than cover prime costs. Financiers connected with the flotation sometimes even arrange that the businesses to be offered to the public shall have a good many orders to fill at specially favourable prices: the loss falling on themselves, or on other companies which they control. The gains to be secured by semi-monopolistic selling, and possibly by some further economies in production are emphasized: and the stock of the trust is absorbed by the public. If ultimately objection to the conduct of the trust is raised, and especially to the strengthening of its semi-monopolistic position by a high tariff or any other public favour, the answer is given that the shareholders are receiving but a moderate return on their investments. Such cases are not uncommon in America. In this country a more moderate watering of the stock of some railways has been occasionally used indirectly as a defence of the shareholders against a lowering of rates, that threatens to reduce dividends on inflated capital below what would be a fair return on solid capital.

3. See above, p. 412.

4. Professor Fetter seems to ignore this lesson in an article on "The Passing of the Concept of Rent" in the Quarterly Journal of Economics, May 1901, p. 419; where he argues that "if only those things which owe nothing to labour are classed as land, and if it is then shown that there is no material thing in settled countries of which this can be said, it follows that everything must be classed as capital." Again he appears to have missed the true import of the doctrines which he assails, when he argues (ib. pp. 423-9) against "Extension as the fundamental attribute of land, and the basis of rent." The fact is that its extension (or rather the aggregate of "its space relations") is the chief, though not the only property ofland, which causes the income derived from it (in an old country) to contain a large element of true rent: and that the element of true rent, which exists in the income derived from land, or the "rent of land" in the popular use of the term, is in practice so much more important than any others that it has given a special character to the historical development of the Theory of Rent (see above, p. 147). If meteoric stones of absolute hardness, in high demand and incapable of increase, had played a more important part in the economic history of the world than land, then the elements of true rent which attracted the chief attention of students, would have been associated with the property of hardness; and this would have given a special tone and character to the development of the Theory of Rent. But neither extension nor hardness is a fundamental attribute of all things which yield a true rent. Professor Fetter seems also to have missed the point of the central doctrine as to rents, quasi-rents and interest, given above.

5. Compare Cassel, Das Recht auf den vollen Arbeitsertrag, p. 81.

The many misconceptions, that have appeared in the writings even of able economists, as to the nature of a quasi-rent, seem to arise from an inadequate attention to the differences between short periods and long in regard to value and costs. Thus it has been said that a quasi-rent is an "unnecessary profit," and that it is "no part of cost" Quasi-rent is correctly described as an unnecessary profit in regard to short periods, because no "special" or "prime" costs have to be incurred for the production of a machine that, by hypothesis, is already made and waiting for its work. But it is a necessary profit in regard to those other (supplementary) costs which must be incurred in the long run in addition to prime costs; and which in some industries, as for instance sub marine telegraphy, are very much more important than prime costs. It is no part of cost under any conditions: but the confident expectation of coming quasi-rents is a necessary condition for the investment of capital in machinery, and for the incurring of supplementary costs generally.

Again a quasi-rent has been described as a sort of "conjuncture" or "opportunity" profit; and, almost in the same breath, as no profit or interest at all, but only a rent. For the time being, it is a conjuncture or opportunity income: while in the long run it is expected to, and it generally does, yield a normal rate of interest (or if earnings of management are counted in, of profit) on the free capital, represented by a definite sum of money that was invested in producing it. By definition the rate of interest is a percentage; that is a relation between two numbers (see above, p. 412). A machine is not a number: its value may be a certain number of pounds or dollars: but that value is estimated, unless the machine be a new one, as the aggregate of its (discounted) earnings, or quasi-rents. If the machine is new, its makers have calculated that this aggregate will appear to probable purchasers as the equivalent of a price which will repay the makers for it: in that case therefore it is as a rule, both a cost price, and a price which represents an aggregate of (discounted) future incomes. But when the machine is old and partially obsolete in pattern, there is no close relation between its value and its cost of production: its value is then simply the aggregate of the discounted values of the future quasi-rents, which it is expected to earn.